The exemption from state income taxes provided by Public Law 86-272 (P.L. 86-272) for the mere solicitation of sales of tangible personal property doesn’t exempt you from having established nexus and being required to file an income tax return. The fact that you have sales solicitation activity in the state generally means you are “doing business” in the state and thus must file an income tax return.

Filing Income and Franchise Tax Returns

The P.L. 86-272 exclusion only applies to taxes based on income for companies that sell tangible personal property. How do such companies claim the protection afforded by P.L. 86-272 and still fulfill their requirement to file a complete and accurate return? The valid filing question usually comes from a nonregistered foreign corporation, LLC, or an LP that owns an interest in another pass-through.

Different Methodologies in Return Filling to Report P.L. 86-272 Income Tax Protection

A. Complete income tax return – include statement explaining P.L. 86-272 exemption. This is the safest but most time-consuming and costly, as a full return is completed but the tax liability presented on Page One is zero or the minimum tax amount.B. Complete income tax return – show apportionment factor numerators as positive amounts; include statement explaining P.L. 86-272 exemption. Complete the individual apportionment factor calculations, but show that the overall apportionment percentage is zero. C. Complete income tax return – show apportionment factor denominators but reflect all numerators as zero amounts; include statement explaining P.L. 86-272 exemption. This methodology will withhold activity in the state until requested.D. Prepare minimal return. Prepare a zero return, which reports zero income, adjustments and apportionment, and which has a statement claiming the P.L. 86-272 exemption.

California is an outspoken state in that their April 2013 Tax News publication actually addressed their position on what constitutes a valid filing. The Franchise Tax Board (FTB) recommends a taxpayer begin with reading FTB Publication 1050 Application and Interpretation of Public Law 86-272 to be sure their activity is protected. California chose method B, stating: “The taxpayer should provide information on Schedule R and attach a statement explaining why the apportioning percentage and business income is zero.”

How have you successfully filed the least burdensome income tax returns while still obtaining PL 86-272 protected activity exemption?

Gary Bingel's expertise focuses on state and local income taxation, and sales and use tax consulting. He has significant experience serving clients in the manufacturing, retail, pharmaceutical, biotechnology, technology and service industries.